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Arming Your Portfolio For Gun Legislation

If you type "Americans love" into Google Search, auto-complete fills the blank with "guns." "Pie" was the closest second in similar searches. The American love affair with firearms has been one of our most contentious "rights." And a profitable, virile, industry. [Related: Dark Side of 3D Printing: Gun Prints Are Becoming More Advanced]

Recent tragedies have seen a groundswell of demands for gun control. President Obama is at the forefront of the renewed sentiments. His proposed initiative to reduce gun violence includes more stringent background checks and a reinstatement of the ban on assault weapons. The NRA, which maintains financial support from gun manufacturers, has wasted no time labeling the president "an elitist hypocrite" for employing a well armed secret service at his disposal.

Though gun-toting enthusiasts and their sponsors voice concerns, early investors in gun-related stocks have been rejoicing. Firearm manufacturer, Smith & Wesson (SWHC), is up 7.21% this week. Sturm, Ruger & Company (RGR) has also been thriving, gaining 10.42%.

Check out the trend in quarterly sales and share prices below:

Columbine, Virginia Tech, Aurora, and now Newtown incited public outcry against firearms, putting gun control on the national agenda. But in doing so, they've also helped the gun industry grow to a roughly $3.5 billion a year institution. Mental health professionals often appear after major acts of violence to deconstruct the killers and warn of copy cats. Even bad publicity seems good for guns.

Gun shops are overwhelmed with demand as buyers load up on weapons before Congressional action. In the US alone there are 5,400 licensed firearms manufacturers trying to keep up. The guns are flying off the shelves (luckily only figuratively) at prices sometimes double what retailers commanded in less panicked times. The most asked for weapon is the same one used in the Sandy Hook shooting. The demand is driving up stocks in the industry.

Sturm Ruger

In the most recent reported quarter, Sturm Ruger received 89% more orders than the previous year for only a fraction of new users and background checks. Net income in the quarter was pushed down by $30 million of capex to expand capacity. Growth is even larger when you consider incongruous share buybacks in previous years that led to steady increases in earnings.

Smith & Wesson

This gun company has grown a lot quicker and is much more volatile with an equity beta of 1.31 (vs. RGR's beta of .44). Smith & Wesson has a had a rocky past in terms of profitability. In the most recent quarter, net income was close to 22 million as opposed to an over $1.5 million loss only a year ago. The company seems to have suffered from excess production capacity. Recent surges in the demand are now supporting SWHC. Not surprisingly modern sporting rifle sales increased 119.1% last year. (Note: not all weapons in this category fall under proposed ban.)

Signs of short-sighted profit

Gains in the gun industry won't last forever. Moral outrage can always alter American tastes. States are already contemplating extra sales taxes on guns to curtail purchases. If changes become permanent, TASER International (TASR) has a place for investors looking at alternatives. TASER is the clear monopoly in its field (it develops, manufactures, and sells electronic control devices (ECD) for use in the law enforcement, military, corrections, private security, and personal defense markets) despite almost no EPS growth and serial lawsuits.

Recent headlines include a move by the Chicago Teachers' Pension Fund to drop its investments in RGR and SWHC. Exodus en masse by investors voting with their money could negatively impact gun stocks. Finally, financial statements from gun manufacturers make special note that recent performance is tied closely with the current political environment.

The list average 1-year return for the 5 stocks mentioned in this artice is 68%.

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